head of one of the most optimistic months for stock markets – commonly known as the Santa Claus Rally in December – Colin Cieszynski analyses how markets have previously responded around this time of year, and looks at the possible consequences of a rate rise by Janet Yellen and the Fed.
Within the report Colin discusses:
• A look back at previous Santa Claus Rallies and returns for the Dow
• 2015’s autumn market performance so far
• How markets will respond to Janet Yellen’s impending decisions on monetary policy and interest rates
It may seem counterintuitive, but if Fed Chair Janet Yellen wants to act like Santa for stocks, she will need to be the Grinch on monetary policy and raise rates as the Fed has been signalling. A decision to be Santa on interest rates could turn her into a Grinch for stocks.
The Fed has recently given indication that it is poised to (potentially) raise interest rates for the first time since the Great Financial Crisis of 2007-2009. For the last several years, stocks have applauded dovish stimulus moves from the Fed, so some traders may wonder if a more hawkish central bank could derail the typical end of year optimism.
In fact, a look at returns for the Dow over the last decade suggests that the opposite to be true. Looking at years where the Fed made a move at its December meeting against the 10-year average, a hawkish decision resulted in stocks performing better (up more or down less) than in years the Fed made a dovish December move.
This outperformance applies for each month between October and February, indicating that hawkish Fed anticipation and follow-through does nothing to dampen traders’ spirits around the holidays. It also suggests that a dovish surprise in December (like another hold decision), could have a negative impact on trading.
Why would this happen? It’s important to remember that dovish stimulus moves are done to prop up a weak economy, whilst a hawkish move is only undertaken when the economy is strong enough to support. New York Fed President Dudley recently confirmed this, indicating a hawkish move by the Fed would be a show of confidence in the economy. Therefore, a decision to raise interest rates could in fact boost optimism about economic and earnings prospects for 2016.
A look at the table below compares this year’s autumn market performance so far with recent years and averages. The strong performance through October and much of November (except a one-week trading correction) means that this year has been very similar to the fall of 2013. In 2013, the Fed delayed QE tapering from September to December, just as it looked like a rate liftoff had been delayed from September to December.
Interestingly, in years when the Fed went dovish in December, markets tanked through October and November, even when 2008 is taken out of the equation. This confirms the notion that dovish moves are usually a function of a weak business environment. Recent trading, then, indicates that traders are increasingly expecting the Fed to raise interest rates at its December meeting.
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